Make a promise: the valuation adjustment mechanism in Chinese private target acquisitions

Abstract

The valuation adjustment mechanism (VAM) is a contingent-payment contractual arrangement used in the Chinese mergers and acquisitions (M&As) market. The ‘two-direction payment’ design of Chinese VAMs can reduce deal uncertainty and generate value, especially for poorly performing companies that can use VAM contracts to boost short-term performance. I find in this empirical investigation that acquirers applying VAM terms have significantly higher market returns after addressing endogeneity. I also document that poorly performing bidders sign larger VAM contracts, pay higher bid premiums and achieve higher operating performance, and which types of firms are more likely to adopt a VAM in transactions.

KEYWORDS:

• Valuation adjustment mechanism
• mergers and acquisitions
• takeovers
• contract design
• contingent payment

JEL Code:

• G34
• K22

The authors acknowledge the financial support from National Natural Science Foundation (Zhejiang), project ID: LQ12G02005. I also appreciate helpful comments and suggestions from the conference participants at the 2018 Chinese Academy of Management Annual Meeting and the 2018 China Financial Innovation Conference (CFIC). The paper received the excellent paper award at the 2018 Chinese Academy of Management Annual Meeting.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 In Chinese ‘对赌协议’.

2 Target firm sellers are the original owners of targets. After they have sold a portion of their shares to acquirers, target firms remain as an independent firms of the acquirers. Sellers of targets are still shareholders of target firms and remain on the key managerial team of the target.

3 According to CSRC regulations, when a firm consistently has three years of negative profits, it can be listed on the mainland stock market. Before being delisted, the stock name is changed to ‘ST + StockName.’ ST refers to special treatment.

4 Listing on the Chinese mainland market is difficult and time-consuming; an alternative way for target shareholders to ‘cash-out’ involves accepting takeover offers from listed companies.

5 http://research.pedaily.cn/report/pay/1260.shtml

6 A cash bonus is generally a certain percentage (20%–50%) of additional profits above the promised performance target.

7 Baseline regressions, using a sub-sample of deals where the bidder owns less than 50% before the transaction and more than 50% thereafter, remain the same. The results are not reported in this paper, but they are available upon request.

8 CSRC: China Securities Regulatory Commission.

9 These studies report that, on average, 3.1%–6.8% of deals adopt earnouts in transactions.

10 Refer to (Golubov, Petmezas, and Travlos 2012) for theoretical arguments and for practical applications of this methodology.

11 According to CSRC regulations, when a firm has consistently had three years of negative profits, this firm can then be delisted from the mainland stock market.

Additional information

Funding

This work was supported by Natural Science Foundation of Zhejiang Province [Grant Number LQ12G02005].